Margins of safety and instability in a macrodynamic model with Minskyan insights

•A macrodynamic model with Minskyan insights is presented.•Firms’ and banks’ desired margins of safety change endogenously.•A higher sensitivity of the desired margins of safety to the investment cycle is conducive to instability.•The relationship between investment and leverage cycles is explored.•The stabilising role of fiscal policy is emphasised.

This paper develops a stock-flow consistent macrodynamic model in which firms’ and banks’ desired margins of safety play a central role in macroeconomic performance. The model incorporates an active banking sector and pays particular attention to the leverage of both firms and banks. It is shown that the endogenous change in the desired margins of safety of firms and banks is likely to transform an otherwise stable debt-burdened economy into an unstable one. The endogeneity of the desired margins of safety can also produce, under certain conditions, investment and leverage cycles during which investment and leverage move both in the same and in the opposite direction. Furthermore, the paper investigates the potential stabilising role of fiscal policy. It is indicated that fiscal policy can reduce the destabilising forces in the macroeconomy when government expenditures adjust adequately to variations in the divergence between the actual and the desired margins of safety.